Tuesday, 17 March 2009


China flexes, and the US catches a chilly reminder

Sydney Morning Herald
Peter Hartcher
March 17, 2009

In the old days countries threatened each other by
sabre-rattling - moving armies, positioning navies,
making physical threats. In the past few days we have
seen the modern way to intimidate another power.

The Chinese premier, Wen Jiabao, expressed concern about
his country's $US1 trillion ($1.5 trillion) holdings of US
government bonds.

"We've lent a huge amount of capital to the US, and of
course we're concerned about the security of our assets.
And to speak truthfully, I am a little bit worried."

That was all it took.

It marked a threshold moment in relations between the
current superpower and the potential one - Beijing
demonstrated that it is prepared to use its financial power
over the US as an instrument of pressure.

US officials, including Barack Obama himself, hastened to
reassure the Chinese over the weekend. "Not just the
Chinese Government, but every investor can have absolute
confidence in the soundness of investments in the US."

Wen's remark was not random. It was made in answer to a
pre-approved question at his annual news conference. It
came just as his Foreign Minister, Yang Jiechi, was in
Washington to negotiate with the US the approach the two
countries would take to the Group of 20 summit in London on
April 2.

And it emerged a few weeks after Hillary Clinton went to
Beijing and explicitly called on the Government to keep
buying US bonds - the Obama Treasury is hoping to sell the
world another $1.7 trillion in treasuries this year to pay
for the US Government's deficit.

In other words, the US, the world's biggest debtor, finds
itself unusually vulnerable. And China, the world's biggest
creditor, is newly powerful.

It is the culmination of the different ways the US and
China have pursued power. In 1992 China formally adopted a
new concept of the national interest it called
"comprehensive national power."

This is officially defined as "the totality of a country's
economic, military and political power". Among these,
economic power has held priority as the basis for all other
forms of power. And this has been the national strategy
ever since.

By contrast, the US, especially under George Bush, put
increasing emphasis on its military as its preferred
instrument of power. Fiscal prudence was not just
overlooked but violated. When Bush's first treasury
secretary, Paul O'Neill, warned the vice-president Dick
Cheney against tax cuts because of the looming deficit,
Cheney said: "Reagan proved deficits don't matter."

O'Neill's resistance cost him his job. Of course, he was
right. The deficit has emerged starkly as a vulnerability
of the US state. It was in Reagan's term that the US went
from being the world's major creditor to becoming its
biggest debtor.

Bush, his ideological and political heir, has left the US,
at the end of a boom, with a deficit of half a trillion
dollars. To fight off recession, Obama is putting the
country into much deeper deficit.

One of China's most influential strategic thinkers, Yan
Xuetong, observed some years ago that China had put its
communist ideologies aside in pursuit of economic growth,
while the US increasingly based its economic policies on
political ideology: "Which is the ideological country now?"
he asked.

The jostling of a US Navy survey vessel by five Chinese
ships in the South China Sea last week provided a timely
illustration of the weakness of America's narrow concept of

The Chinese ships crowded around the US vessel and put
wooden barriers in the water; the US ship turned its
firehoses on the Chinese sailors.

The US might have decided to press its case. But it would
then have to face the reality that its defence budget is
crucially supported by the very country it wanted to

China's options for retaliation would include abandoning US
government bonds. It could even dump its existing US
treasuries, which could seriously damage the country's
ability to finance itself on reasonable terms. Obama's
recovery plans could be at risk.

But, of course, if Beijing waged fiscal war on Washington,
it would rebound. Twenty-one per cent of Chinese exports go
to the US. By sabotaging the US recovery, China would be
crimping its own.

This is the financial version of the doctrine of "mutually
assured destruction" that kept the US and the Soviet Union
from launching their nuclear arsenals at each other during
the Cold War.

Wen made exactly this point in his news conference: "On the
foreign reserves issue, the first consideration is our
national interest. But we also have to consider the
stability of the overall international financial system, as
the two factors are interlinked."

The market reaction to Wen's remarks took this into
account. Investors read the comment as a negotiating ploy.
Already, Obama has agreed to support China's demand for
voting power in the International Monetary Fund, and no
doubt other demands are under negotiation in Washington
right now.

Still, the world nearly came to an end twice in the Cold
War, during the Cuban missile crisis of 1962 and Operation
Able Archer in 1983. The deterrent power of mutually
assured destruction depends on rationality and sound flows
of information, never assured in a real crisis.

As Lawrence Summers, the chairman of Obama's council of
economic advisers, said five years ago: "It surely cannot
be prudent for us as a country to rely on a kind of balance
of financial terror." Yet that is exactly the calculus
holding together what is left of the global economy.

Peter Hartcher is the Herald's international editor


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